vol. 60, no. 3 (January), 1994,
pp. 771-73
The Experience of Free Banking
edited by Kevin Dowd
London: Routledge, 1992, pp. xi, 275
Eight economists exploring on both sides of the Atlantic and both north
and south of the equator have unearthed more episodes of free banking and
near-free banking than even specialists in the field would have thought
existed. Nine of the book's eleven chapters are organized on a chapter-per-country
basis and are arranged in alphabetical order by country. Editor/contributor
Kevin Dowd deals in separate chapters with free banking in Australia and
in the United States. In between these two countries, alphabetically speaking,
are free-banking episodes in Canada (Kurt Schuler), Colombia (Adolfo Meisel),
Foochow, China (George A. Selgin), France (Philippe Nataf), Ireland (Howard
Bodenhorn), Scotland (Lawrence H. White), and Switzerland (Ernst Juerg
Weber). Except for White's path-breaking treatment of free-banking in Scotland
before 1844, reprinted from White [2], the contributions to this volume
are original.
A short introductory chapter
by Dowd is followed by a 40-page overview chapter, in which Schuler identifies
the evolutionary origins of free banking and shows that competition among
banks involved a good deal of cooperation in the form of clearing arrangements.
He compares the performance of free banking with that of central banking
and employs the case-study method to deal with three causes for the demise
of free banking: theoretical debate underlay the demise of free banking
in Britain; considerations of seigniorage (i.e. monopoly rent-seeking by
government) accounted for the end of free banking in China, France, and
Sweden; and efforts to deal with economic crises put an end to free banking
in the British Colonies, France, Germany, and the United States. Schuler's
overview ends with a tabular presentation that spans six pages. For each
of some sixty different episodes, the table indicates the years that free
banking prevailed as well as the year that central banking began, lists
the particular restrictions that applied during the episode, suggests the
reason for free banking's demise, and cites source material. The information
density in these half dozen pages is remarkably high.
As its title indicates,
this book is about the experience with—as opposed to the theory of—free
banking. But the opening chapters provide enough in the way of carefully
thought out definitions and hints about the corresponding theory to make
the accounts of the actual episodes of free banking generally understandable.
The contributors do not use the term free banking as some theoretical ideal—analogous,
say, to perfect competition as applied to the nonbanking sectors of the
economy. Rather than allow free banking to be defined out of existence
or to refer to minor aberrations in banking history, they simply recognize
that there have been banking experiences involving some degree of freedom—in
some countries more so than in others and at some times more so than at
others. Those experiences that allow for at least some meaningful contrast
to central banking or monopoly note issue qualify as episodes of free banking.
As Dowd and Schuler recognize,
scope for contrast between free and central banking is multidimensional.
Their discussion suggests that there are at least four freedoms. The first
two are freedoms in a literal sense: freedom of entry into the business
of banking and freedom of each entrant to issue its own banknotes. The
second two derive from the absence of centralized crisis management—as
in government-sponsored lender of last resort—and the absence of macroeconomic
stabilization policy. Dealing rigorously with the combined effects of the
two instances of "freedom of" together with the two instances of "freedom
from" would require theoretical support from several fields of study—both
separately and interactively—including macroeconomics, finance, money,
and industrial organization. For instance, the fundamentals of monetary
theory come into play when the competitive process involving multiple issuers
of banknotes imposes an effective constraint on note issue. At some point
on the way to full-fledged free banking, the competitive forces themselves
become the binding constraint, and the link between the money supply and
the underlying quantity of commodity money, e.g. gold, loses much of the
significance it once had. Whether the money supply is limited by competition
or by commodity money in particular episodes is not always clear in the
accounts of the different countries' banking experiences. And connecting
this issue in monetary theory with issues relating to market structure,
risk management, and macroeconomic stability would require more theory
than is now extant. In trying to discern the meaning of the many twists
and turns of banking history, the reader is constantly reminded of how
many issues in free
banking's research agenda have yet to be explored.
In lieu of a widely accepted
theory of free banking and implied standards by which to judge the actual
performance of the banking industry in conditions of laissez faire,
Schuler (p. 19) and others adopt conventional standards by which to judge
alternative banking regimes. How well does the banking industry foster
economic growth, intermediate efficiently between lenders and borrowers,
maintain stability of prices or exchange rates, avoid problems of fraud
and counterfeiting, prevent the overissue of credit, and discourage bank
runs and panics? When graded on a curve, free banking wins out over central
banking on all counts. Episodes involving some hybrid set of banking institutions
confront the researcher—and reader—with judgment calls as to whether the
bad performance of the banking industry is attributable to too much or
too little freedom. Judgments by the contributors to this volume are made
in the light of the economist's general understanding of the merits of
individual as compared to central direction of economic activity.
Some readers might get the
idea that any goal central banks set for themselves (price-level stability
or an accelerated rate of economic growth) can be better achieved as an
unintended consequence of the separate actions of profit-maximizing free
bankers. The episodic history provides ample evidence in favor of free
banking, one suspects, largely because, with central banking, political
incentives cut against economic goals. Inflation that serves political
purposes and the consequent degradation of economic performance can easily
be beat by a de-politicized banking industry. The Theory of Free Banking
as set out by George Selgin [1] together with the basics of growth theory
makes it clear that free-banking is not a means to the ends of central
banking. Market forces in a regime of competitive note issue, for instance,
allow for changes in the money supply in the face of changes in money demand,
but those same market forces hold the line on money in the face of changes
in real economic output. The contrast between policy goals and market performance
can be made with the help of MV=PQ: while the goal of central banking may
be to hold P constant despite changes in V and Q, the consequence of free
banking is to hold MV constant while changes in Q are offset by changes
in P. Further, in a free-banking regime the economy's real rate of economic
growth, the rate of change of Q, is sustainable but not necessarily the
highest possible. Laissez faire allows the economy to grow at its
natural rate—which corresponds to the choices of market participants as
between present and future consumption, given the intertemporal terms of
trade as dictated by resource constraints and technological considerations.
In one sense, the adoption
in the present volume of conventional standards—rather than standards more
consistent with free-banking theory—strengthens the book's central message.
Free-banking fares well even when the standard of judgment stacks the cards
against it. At the same time, the ultimate inappropriateness of judging
free-banking performance against central-banking standards constitutes
the book's major weakness and hints at the breath and depth of the research
agenda that still awaits free-banking scholars.
Roger W. Garrison
Auburn University
References:
1. George A. Selgin, The Theory of Free Banking: Money
Supply under Competitive Note Issue. Totowa, New Jersey: Rowman and
Littlefield, 1988.
2. Lawrence H. White, Free Banking in Britain: Theory,
Experience and Debate, 1800-1845. Cambridge: Cambridge University Press,
1984.
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